Impact of income diversification on bank stability: a cross-country analysis

Abstract

PurposeThe impact of diversification on bank stability and risk remains an ongoing topic of discussion with inconclusive results. Hence, this study investigated the implications of income diversification on bank stability within African markets.Design/methodology/approachThe study utilised longitudinal financial data on 45 countries from 2000 to 2017 and employed static and dynamic panel model estimation.FindingsThe results of the study suggest income diversification technique could improve financial stability throughout typical and crisis periods which validate portfolio management theory. The study also confirms the “too big to fail” hypothesis, extensive diversifying over an optimal range negatively impacts stability. Banks with a high level of liquidity, a higher operating efficiency and a larger deposit ratio become more resilient. Banking capital regulations found to be the appropriate monitoring instrument for lowering risks and maintaining stability. However, profitability was found to have a positive effect on bank risk-taking. The finding also suggests that political institutions have substantial, direct implications that are positively related to bank fragility. Macroeconomic factors such as gross domestic product (GDP) growth and inflation also influenced bank stability.Practical implicationsThis study has important implications for bankers, regulators and academicians concerned about the effect of diversification on a bank’s risk-taking or stability in developing economies.Originality/valueTo the best of the author’s knowledge, this is the first study on Africa to analyse the quadratic influence of income diversification and the effects of political institutions on the level of bank stability.

Asset Quality and Financial Stability: An Empirical Review of Commercial Banks in Kenya

“…Further, it is an indication that commercial banks in Kenya could improve their financial stability by increasing their level of total assets. Bank efficiency measured as the cost to gross income was negatively statistically significant with financial stability of commercial banks in Kenya, the more the bank is efficient the more it takes higher risk and this negatively affect the financial stability, which is in line with the study of (Adem, 2023). Further leverage measured as total equity to total assets was positively statistically significant with financial stability of commercial banks in Kenya.…”

Enhancing bank stability from diversification and digitalization perspective in ASEAN

“…On the other hand, it might increase bank volatility, as a wide range of products might imply high cost and complexities. However, the result is not consistent with Adem (2022) and Li (2019) that diversification significantly impacts bank stability. The negative coefficients on CDO and Digital suggest that the presence of CDO and clearer digital plans for banks’ stakeholders reduces the potential bank risk, thereby contributing to stability.…”

“…Prior studies indicate that bank diversification strategy basically conforms to the portfolio investment theory. Bank diversification might increase bank stability and plays a silent role in managing risk and supporting smoothing operation in the banking system (Moudud-Ul-Huq et al, 2018;Amidu and Wolfe, 2013;Le, 2021;Tariq et al, 2021;Genberg, 2020;Nguyen et al, 2012;Hsieh et al, 2013;Adem, 2022). Banks might benefit from generating new sources of income and reduce their risk by diversifying their income.…”

“…However, the activities might also increase bank’s risk which is represented by the volatility of income (Zhou, 2014). In this section, we measure stability by using standard deviation of ROA and ROE ( σROA and σROE ) to represent bank risk and income volatility following Li (2019), Zhou (2014) and Adem (2022). The higher value of standard deviations indicates greater risk.…”

“…The portfolio theory suggests that revenue diversification minimizes banks’ risk, as it combines different sources of income (Le, 2021). Tariq et al (2021) and others (such as Genberg, 2020; Moudud-Ul-Huq et al , 2018; Nguyen et al , 2012; Hsieh et al , 2013; Adem, 2022; and Meslier et al , 2014) document that banks use diversification strategy to increase performance, respond to the dynamic environment and enhance stability. Implementation of diversification activities might reduce the probability of banks’ failure or improve banks’ stability.…”